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A Theory of Stock Exchange Competition and Innovation: Will the Market Fix the Market?

Author

Listed:
  • Eric Budish
  • Robin S. Lee
  • John J. Shim

Abstract

Will stock exchanges innovate to address latency arbitrage and the arms race for speed? This paper models how exchanges compete in the modern electronic era and how this shapes incentives for market-design innovation. In the status quo, exchange trading fees are competitive, but exchanges earn economic rents from selling speed. These rents create a wedge between private and social incentives to innovate and support the persistence of an inefficient market design in equilibrium of a market-design adoption game. We discuss implications for policy and insights for the literatures on market design, innovation, and platforms.

Suggested Citation

  • Eric Budish & Robin S. Lee & John J. Shim, 2024. "A Theory of Stock Exchange Competition and Innovation: Will the Market Fix the Market?," Journal of Political Economy, University of Chicago Press, vol. 132(4), pages 1209-1246.
    • Handle: RePEc:ucp:jpolec:doi:10.1086/727284
    DOI: 10.1086/727284
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    Cited by:

    1. Parag A. Pathak & Alex Rees-Jones & Tayfun Sönmez, 2025. "Immigration Lottery Design: Engineered and Coincidental Consequences of H-1B Reforms," The Review of Economics and Statistics, MIT Press, vol. 107(1), pages 1-13, January.
    2. Iordanis Angelos Kalaitzoglou, 2025. "Cleaning the carbon market! Market transparency and market efficiency in the EU ETS," Annals of Operations Research, Springer, vol. 347(1), pages 501-533, April.
    3. Thibaut Mastrolia & Tianrui Xu, 2025. "Optimal Rebate Design: Incentives, Competition and Efficiency in Auction Markets," Papers 2501.12591, arXiv.org.
    4. Mark Marner-Hausen, 2022. "Developing a Framework for Real-Time Trading in a Laboratory Financial Market," ECONtribute Discussion Papers Series 172, University of Bonn and University of Cologne, Germany.
    5. Alex Frino & Ognjen Kovačević & Vito Mollica & Robert I. Webb, 2020. "The sensitivity of trading to the cost of information," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(10), pages 1631-1644, October.
    6. Franzoni, Francesco & Di Maggio, Marco & Egan, Mark, 2019. "The Value of Intermediation in the Stock Market," CEPR Discussion Papers 13936, C.E.P.R. Discussion Papers.
    7. Brolley, Michael & Zoican, Marius, 2023. "Liquid speed: A micro-burst fee for low-latency exchanges," Journal of Financial Markets, Elsevier, vol. 64(C).
    8. Wolfgang Kuhle, 2023. "Latency arbitrage and the synchronized placement of orders," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 9(1), pages 1-18, December.
    9. Matteo Aquilina & Eric Budish & Peter O’Neill, 2022. "Quantifying the High-Frequency Trading “Arms Race”," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 137(1), pages 493-564.
    10. Yan Chen & Peter Cramton & John A. List & Axel Ockenfels, 2021. "Market Design, Human Behavior, and Management," Management Science, INFORMS, vol. 67(9), pages 5317-5348, September.
    11. Vasilios Mavroudis & Hayden Melton, 2019. "Libra: Fair Order-Matching for Electronic Financial Exchanges," Papers 1910.00321, arXiv.org.
    12. Le Moign, Caroline, 2025. "Securing passive liquidity: The impact of Europe’s first asymmetric speed bump on market liquidity," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 101(C).
    13. Michael Brolley & Marius Zoican, 2019. "Liquid Speed: On-Demand Fast Trading at Distributed Exchanges," Papers 1907.10720, arXiv.org.
    14. Tayfun Sönmez & M. Utku Ünver, 2024. "Matching under Non-transferable Utility: Applications," Boston College Working Papers in Economics 1069, Boston College Department of Economics, revised 01 Oct 2025.
    15. Matteo Aquilina & Eric Budish, 2020. "Quantifying the High-Frequency Trading “Arms Race†: A Simple New Methodology and Estimates," Working Papers 2020-86, Becker Friedman Institute for Research In Economics.
    16. Liu Yang & Yaozhong Wang & Baichuan Peng, 2024. "Dynamic Mechanisms of R&D Innovation in Chinese Multinational Corporations: The Impact of Government Support, Market Competition and Entrepreneurial Spirit," Sustainability, MDPI, vol. 16(22), pages 1-25, November.
    17. Milena Wittwer, 2021. "Connecting Disconnected Financial Markets?," American Economic Journal: Microeconomics, American Economic Association, vol. 13(1), pages 252-282, February.
    18. Sunghun Ko & Jinsuk Park, 2025. "Impact of Volatility on Time-Based Transaction Ordering Policies," Papers 2512.23386, arXiv.org.
    19. Ari Kutai & Daniel Nathan & Milena Wittwer, 2025. "Exchanges for Government Bonds? Evidence During COVID-19," Management Science, INFORMS, vol. 71(10), pages 8948-8966, October.
    20. Hendershott, Terrence & Rysman, Marc & Schwabe, Rainer, 2025. "Stock exchanges as platforms for data and trading," Journal of Financial Markets, Elsevier, vol. 75(C).
    21. Robert McLaughlin & Nir Chemaya & Dingyue Liu & Dahlia Malkhi, 2024. "CLVR Ordering of Transactions on AMMs," Papers 2408.02634, arXiv.org, revised Jul 2025.
    22. Suchismita Mishra & Le Zhao, 2021. "Order Routing Decisions for a Fragmented Market: A Review," JRFM, MDPI, vol. 14(11), pages 1-32, November.
    23. Lilac Nachum, 2021. "Value distribution and markets for social justice in global value chains: Interdependence relationships and government policy," Journal of International Business Policy, Palgrave Macmillan, vol. 4(4), pages 541-563, December.
    24. Daniel Chen & Darrell Duffie, 2021. "Market Fragmentation," American Economic Review, American Economic Association, vol. 111(7), pages 2247-2274, July.
    25. Agostino Capponi & Ruizhe Jia & Ye Wang, 2022. "The Evolution of Blockchain: from Lit to Dark," Papers 2202.05779, arXiv.org.

    More about this item

    JEL classification:

    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • D47 - Microeconomics - - Market Structure, Pricing, and Design - - - Market Design
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L5 - Industrial Organization - - Regulation and Industrial Policy

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